Expert Testimony Improperly Excluded in Securities Fraud Trial

Written on Tuesday, December 15th, 2015 by T.C. Kelly
Filed under: Expert Opinions, ExpertWitness

A federal jury in Connecticut convicted Jesse Litvak of multiple crimes, including securities fraud, making false statements to the United States government, and defrauding the government. A recent decision of the U.S. Court of Appeals for the Second Circuit concluded that Litvak should receive a new trial on the securities fraud counts because the District Court improperly limited the expert testimony that Litvak wanted to present.

Litvak’s Trial

Litvak was a securities broker and trader at an investment banking firm. The government charged Litvak with multiple counts of securities fraud and of making false statements to government officials, as well as a single count of fraud against the United States. The accusations arose from transactions in Residential Mortgage-Backed Securities (RMBS). Typical RMBS are collections of mortgages that have been purchased from lenders and packaged together. Shares of the packages are then sold to investment funds and other investors.

Litvak was accused of making false statements to investment managers about the price his firm paid to acquire certain RMBS, the price he had negotiated to sell them, and his firm’s role in the transactions. The indictment alleged that Litvak made the misrepresentations in order to earn secret profits on the transactions. The jury convicted Litvak of nine counts of securities fraud, four counts of making false statements to the government, and one count of defrauding the government.

Materiality of Litvak’s False Statements

The false statements that Litvak made to investors were included in reports that were filed with the Treasury Department. The government relied on those reports as proof that Litvak made false statements to the government and that he defrauded the government.

All of those crimes depended on proof that the statements were material, meaning they were the kind of statements that could influence a decision made by a person who relied upon them. The Court of Appeals concluded that the investors, not the Treasury Department, relied upon Litvak’s statements when making investment decisions. Since the Treasury Department made no decisions that could have been influenced by Litvak’s false statements, the Court of Appeals reversed his convictions for making false statements to the government and for defrauding the government.

The Court of Appeals arrived at a different conclusion with regard to the securities fraud counts. The court concluded that the jury was entitled to find that Litvak’s misrepresentations to the investment managers were material to their decisions to purchase the RMBS. While Litvak was not entitled to a reversal of his securities fraud convictions on the ground that they were unsupported by evidence, the Court of Appeals next asked whether Litvak was denied a fair trial when the District Court excluded his expert testimony.

Expert Testimony Regarding Materiality

Litvak wanted to call Ram Willner as an expert witness. In addition to serving as a professor of finance, Willner gained extensive experience in the purchase and sale of RMBS during his employment with various investment firms.

While the government did not directly challenge Willner’s qualifications as an expert, the trial court questioned whether he could give expert testimony when his opinions were not based on a scientific methodology. In a footnote, the Court of Appeals noted that the Federal Rules of Evidence permit a wide variety of expert testimony, not just opinions based on science. Expertise can be gained from experience and specialized training and, in appropriate cases, can be based on personal knowledge that is not gained from traditional scientific methods. If it is helpful to the jury, testimony about industry practices is admissible when it is based on specialized knowledge.

Litvak proposed to have Willner testify about the process investment managers use to value RMBS. In Willner’s view, the price that a seller paid for RMBS is not relevant to the buyer’s determination of their value, and therefore cannot be material to a decision to buy or not to buy them. In essence, Willner would have testified that assertions sellers make about their acquisition costs are never reliable and everybody knows that, so investment managers do not rely upon them when they value the security.

The Court of Appeals concluded that Willner’s opinion that Litvak’s misrepresentations were not material may have been inadmissible because it addressed the ultimate legal conclusion that only the jury could make. However, Willner proposed to testify not just about whether Litvak’s misrepresentations were material to the investors’ decisions to buy shares from his firm, but about the unlikelihood that statements of that nature would be material to a reasonable investor.

The Court of Appeals decided that Willner’s proposed testimony concerning the way that investment managers make decisions to buy RMBS at particular prices (including their disregard of a seller’s claimed acquisition costs when they make those decisions) was relevant to the jury’s assessment of the materiality of Litvak’s misrepresentations. The proposed expert testimony undermined the testimony of the investment managers who claimed that Litvak’s representations about his firm’s purchase price influenced their decisions to pay the agreed-upon price for the RMBS shares they purchased from Litvak’s firm. Had the jury heard Willner’s testimony, it could have decided that Litvak’s misrepresentations were not likely to have influenced the investment managers and were therefore not material.

The Court of Appeals held that excluding Willner’s testimony unfairly deprived Litvak of an opportunity to defend against the securities fraud charges. The Court of Appeals therefore reversed those convictions and granted Litvak a new trial.

Expert Testimony Regarding Agency

Litvak also proposed to call a second expert witness, an attorney who had substantial experience working as a compliance officer in the securities industry. The attorney would have testified that brokers in Litvak’s position do not work as agents for investors who buy shares in RMBS. Rather, they act on their own behalf in an arm’s-length relationship with investors.

At least one of the investment managers called by the government testified that he viewed Litvak to be acting as an agent rather than a principal. In light of that testimony, the jury might have concluded that the investment manager placed great reliance on Litvak’s statements (and that the statements were therefore material to the transaction) because they were coming from the investment manager’s agent. If the jury had heard an expert explain that Litvak was not, in fact, an agent for the investment manager, the jury would have been less likely to conclude that Litvak’s false statements were material to the investment manager’s purchasing decisions. Consequently, if the government takes Litvak to trial again, the District Court must permit expert testimony that Litvak was not acting as an agent for the investors.

About T.C. Kelly

Prior to his retirement, T.C. Kelly handled litigation and appeals in state and federal courts across the Midwest. He focused his practice on criminal defense, personal injury, and employment law. He now writes about legal issues for a variety of publications.

About T.C. Kelly

Prior to his retirement, T.C. Kelly handled litigation and appeals in state and federal courts across the Midwest. He focused his practice on criminal defense, personal injury, and employment law. He now writes about legal issues for a variety of publications.